Earlier last month, we discussed the idea around being long IDR on the pretext of global investors seeking yield in relatively attractive geographies in the EM complex (of which SEA was one of them), as a function of the persistence of global monetary easing and negative rates in Japan and Europe. The trade idea was based on a lack of a responsive move in the volatility of Indonesian assets (FX, CDS, Jakarta composite) during the January-March risk aversion move. Across peers like Malaysia, Singapore, Phillipines for example during the period, short-end FX vols traded relatively tight. Indonesian equities also remained rangebound, and rallying in the late stages of the risk-off period, when peers like Thailand and Malaysia and Singapore barely broke highs. Domestic macro proves constructive with YoY GDP at 5.0% with the time series looking to turn higher, after a consistent drag lower since 2011, inflation is stable at 4.5%, unemployment is at historical lows of 6.0%, and credit growth is at 9.6% YoY alongside good banking system resilience, with NPL’s at 2.7% gross. With a BI rate of 6.75%, cut from 7.50%, one can’t lie the yield is stil attractive, and the monetary policy cutting itself is more as a function of global factors (Fed, China, etc), more likely than not than idiosyncratic elements. In addition to this, FDI inflows remain strong with Japan notably increasing annual FDI to the SEA region at levels faster than to China and Hong Kong. Collectively, I think these are all quite attractive factors to be long IDR.

​A long on most EM now, is an implicit USD short, and with the Fed opening the door for a Jun/Jul hike (July if just wanting to dodge the Brexit risk premium, and avoid tightening financial conditions further globally and the USD and US short end responding, being short USDIDR, doesn’t make quite sense, unless say the Fed disappoints or the trade banks on a ‘sell-the-fact’ event on June/July. Due to the carry-trade nature of the JPY, and the FDI inflows mentioned, being long the IDRJPY may make more sense to avoid being caught with the implicitly long USD characteristic of the trade. ​

IDRJPY vs 5y Rate Spread

IDRJPY vs Indon 5y CDS

Besides the fact that spot is sitting at 2009 lows, we can see that spot tracks the 5y yield spread (ID5y – JP5y) between the two nations, and only having recently diverged quite significantly. The chart to the right shows the overlay between the 5y Indonesia CDS, and spot IDRJPY (inverted) although the relationship looks to be a lot more spurious, we can see that since 2011, spot lagged CDS tightening episodes, of which we are currently witnessing. Furthermore, Jakarta Composite’s newly established range with lower extremes in at 4500~, looks to also imply a higher IDRJPY rate. On a total-return perspective, one can see spot move to at least 12% higher in a 4-6 month time span, with a very attractive risk:reward of 3-4:1 depending on how tight stop placement goes, and carry accumulates to 285 bps over 5 month period. ​